The Use And Abuses Of Green Finance

The Cop26 Summit in Glasgow is shaping up to be a Disappointment. The hope that Emerging Markets, which belch-out much of the World's Greenhouse Gases, would announce Ambitious Proposals is being Dased. The Plans of China, India, and Brazil, all underwhelm. There is No sign this will be the COP that Kills Coal, as Britain, the Host, wanted. World Leaders have still Not agreed to Stop Subsidising Fossil fuels.

But One area where Enthusiasm is growing is Climate Finance. Financial Institutions representing nearly $9 Trillion in Assets Pledged to Uproot Deforestation from their Invesment Profolios. The most striking Announcement has come from the Glasgow Financial Alliance for NetZero (GFANZ), a Coalition Co-Chaired by Mark Carney, a former Governor of the Bank od England. Its Members, which include: Asset Owners, Asset Managers, Banks, and Insurers, hold about $130 Trillion of Assts. They will try to Cut the Emissions from their Lending and Investing to Net Zero by 2050. Can the Financial Industry really Save the World.

In principle, it has a Huge Role to play. Shifting the Economy from Fossil Fuels to Clean Souces of Energy requires a vast Reallocation of Capital. By 2030, around $4 Trillion of Investment in Clean Energy wil be needed each year, a Tripling of current levels. Spending on Fossil Fuel must Decline. In an ideal World the Profit Incentive of Institutional Investors would be aligned with Reducing Incentive of Emissions, and these Owners and Financiers would Control the Global Assets that create Emissions. Asset Owners would have both the Motive and the means to Reinvent the Economy. The Reality of Green Investing Falls Short of this Ideal.

The First Problem is Coverage:

The estimates that Listed Firms which are Not State-controlled Companies, such as Coal India or Saudi Aramco, the World's Biggest Oil Producer, are a Big part of the Problem, and they do Not operste under the sway of Insitutional Fund Managers and Private Bnkers.

A Second Issue is Measurement:

There is as yet No way to Accurately Assess the Carbon Footprint of a Portfolio without Double Counting Emissions from a Barrel of Oil could appear in Carbon Accounts of the Firms that are Drilling, Refining, and Burning the stuff. Methodologies behind attributing Emissions to Financial flows are even Sketchier. How should Shareholders, Lenders, and Insures Divvy-UP the Emissions from a Coal-Fired Power Plant, for instance?

The Third Problem is Incentives:

Private Financial Financial Firms aim to Maximise Risk-Adjusted Profits for their Clients and Owers. This is Not well-aligned with Cutting Carbon. The easiest way to Cut the Carbon Footprint of a Diversified Portfolio is to Sell the part of it Invested in Dirty Assets and put the proceeds in Firms that never Emitted much, such as, Facebook. Together, the Five Biggest American Tech Firms have a Carbon Intensity: Emissions per Unit of Sales, of about 3% of the S&P 500 Aversge.

Heavily Polluting Firms or Assets will often find New Owners. If you can Brush Off the Stigma, it can be Profitable to hold Assets that can Legally generate Untaxed Externalities, in this case Pollution. As Shareholders urge Oil Majors to Clean UP, the Oilfields they Sell are being bought by private-Equity Firms and Hedge Funds, away from the Public Eye. Pledges alone do Not alter the Fact that Firms have Little reason to Invest Trillions in Green-Technologies that still have Mediocre Risk-Adjusted Returns.

Fine-Tuning can Help. Measurement should be Improved. The EU is Rolling Out Mandatory Carbon Reporting for Businesses and the US is considering it. Some Accounting bodies want to Standardise how Climate Measures are Disclosed. Assets Owners, such as Pension Funds, should Hold-On to their Investments in Polluting Firms and use them to Help bring about Change. Institutional Investors also need to Build Up their Venture Capital arms to Finance New Technologies, such as Green Cement.

Pledges like GFANZ are good as far as they go, but the World needs a Widespread Price on Carbon if Finance is to work wonders. That would Target All Firms, Not just those Controlled by some Institutional Investors. The urge to Avoid the Tax would Supercharge efforts to count Emissions. Firms and Governments would have an Incentive to grapple with Questions of who is Polluting and who should Pay. Crucially, a Carbon Price would Align the Profit Incentive with the Goal of Reducing Greenhouse Gases. The Job of the Financial System would then be to Amplify the Signal sent by the Price of Carbon. That combination would be a Powerful Engine for Changing how Economies work.










NYC Wins When Everyone Can Vote! Michael H. Drucker